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Monday, April 2, 2012

Question: I own my building and want to lease it to the buyer of my business for more rent than I currently pay. Will this effect my valuation?

Answer: If you own your building and plan to lease it to your buyer at a higher rent than you are currently charging yourself, a negative adjustment (reduction) will have to be made on your annual earnings to reflect the new amount. For example, if you charge yourself $8,000 a month ($96,000 annually) but the market rent you will charge the buyer is $15,000 a month ($180,000 annually), you will have to subtract $84,000 from earnings for each year you are under charging yourself. The problem compounds when you multiply the negative adjustment by the pricing multiple. If your business is priced at 3 times discretionary earnings, the net negative impact of the adjustment is a $252,000 hit AGAINST your selling price- ouch! From this illustration you can see that a fair market adjustment can be a significant, so plan ahead and charge yourself properly after discussing the tax consequences with your CPA.

1 comment:

A reader just asked this great question and since many of you may be wondering the same, I thought I would confidentially post it here:

"Hi Julie,I am not getting your point. If I charge rentals more for business then how it negatively affects me?"

Here is my reply:

Great question! I'm going to try a mobile reply, so let me know if you get this!

To answer your question, higher rent for the buyer after the sale will create an increased rent expense going forward.

That increased expense needs to be included when calculating your Seller's Discretionary Earnings (SDE) in order to give the buyer a true picture of their available discretionary cash flow after the sale.